Question textThe ordinary shares of NCP are expected to pay $0.75 per share in dividends at the end of this year. Dividends are expected to grow at an annual rate of 5% forever.Note: for calculation questions in the following parts, round the answers to 2 decimal placesa) If NCP's current market price is $30 per share, the share's expected rate of return is Answer 1 Question 5[input]%b) If your required rate of return is 8% p.a., the value of the share for you is $Answer 2 Question 5[input]c) You should Answer 3 Question 5[select: , not buy, buy] the share because the expected rate of return is Answer 4 Question 5[select: , less, more] than your required rate of return or the value of the share is Answer 5 Question 5[select: , higher, lower] than the current market price.

Question

BlackTom AI · Accepted Answer

Start by identifying the key inputs for this valuation using the Gordon Growth Model, which applies when dividends grow at a constant rate.

First, note the given data: D1 = 0.75 (dividend at year 1), g = 5% = 0.05, and current price P0 = 30.

Option 1 (the expected rate of return given P0 = 30):
- Under the Gordon Growth Model, P0 = D1 / (r - g). Rearranging gives r = (D1 / P0) + g.
- Compute D1 / P0 = 0.75 / 30 = 0.025 (2.5%).
- Add the growth rate g = 0.05 (5%), yielding r = 0.025 + 0.05 = 0.075, or 7.50%.
- Therefore, the share’s expected rate of return at the current price is 7.50%.

Option 2 (value of the share when your required return is 8%):
- With r = 8% and g = 5%, the Gordon Model gives P = D1 / (r - g) = 0.75 / (0.08 - 0.05).
- Compute the denominator: 0.08 - 0.05 = 0.03.
- Compute the price: 0.75 / 0.03 = 25.00.
- Thus, the value of the share for a required return of 8% is 25.00.

Option 3 (buy/not buy decision based on comparison):
- Compare the expected rate of return (7.50%) to the required rate of return (8%).
- Since 7.50% < 8%, the investment does not meet the required return threshold.
- Consequently, you should not buy the share (not buy).

Option 4 (comparison of expected return vs required return phrasing):
- The statement must reflect that the expected return is less than the required return. Hence,
- The correct fill is: the expected rate of return is less than your required rate of return.

Option 5 (valuation vs current market price):
- Since the model-implied value at an 8% required return is 25.00, which is below the current market price of 30, the share is overpriced at the current price.
- Therefore, the value is lower than the current market price (value 25.00 is lower than 30.00).

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